As expected attendance was modest – no doubt the result of the cost-cutting mandated by economic conditions, coupled with reduced reinsurance-dispute frequency and severity — but the conference was nevertheless a great success.  The presentations were thoughtful, interesting and professionally useful, and the smaller group of attendees not only facilitated robust – and sometimes, spirited – discussions during the program, but also provided a relaxed atmosphere conducive to networking during the breaks.  I, for one, returned home with “fresh perspectives” on a number of reinsurance-related issues, and those perspectives have proved to be good fodder for brainstorming.

Conference co-chairs Edward K. Lenci (Partner, Hinshaw & Culbertson LLP, New York, NY), Leslie J. Davis (Vice President & Assistant General Counsel, Gen Re; Senior Vice President & General Counsel, United States Aviation Underwriters, Inc.), and Wendy R. Taylor (Vice President and Associate Counsel, Chubb & Son, a division of Federal Insurance Company), outdid themselves on this one.  All three devoted a great deal of time and effort into organizing and implementing the conference over a several month period.  Ed spearheaded the effort and was the event’s chief moderator, while Wendy did double duty as a co-manager and faculty member.   Wendy also had the honor of introducing the keynote speaker, Commissioner Thomas B. Considine of the New Jersey Department of Banking and Insurance (Commissioner Considine also chairs the National Association of Insurance Commissioners‘ Reinsurance Task Force).  Ed’s, Wendy’s and Leslie’s hard work and devotion paid great dividends to all who attended.

Conference-sponsor HarrisMartin Publishing likewise did a superb job organizing, implementing, and promoting the event, and handling all of the administrative, technical, and CLE-related details.  The three key players were Conference Director Vicki Gilbreath; Reinsurance Report Editor Marcy Kowalchuk, whom I’ve known since she was a Mealey’s Reinsurance Reports editor some years back; and Editorial Director Jeff Andrus.  All three worked diligently and intensely on the project, and demonstrated their impressive editorial, publishing, promotional and event-management skills in the process.  They were quick with an effective solution whenever there was a problem.

Of course, the conference might have been a rather mind-numbing and painful way to earn CLE credit were it not for the superb faculty, all of whom delivered and facilitated interesting and thought provoking discussion and debate on several diverse reinsurance-related topics, and did so with great enthusiasm, skill and aplomb.  Their credentials and reputations speak for themselves:

Finally, I’d like to thank Richard D. Faulkner, a name partner at the Richardson, Texas-based firm of Blume, Faulkner, Skeen & Northam, who traveled all the way from the Dallas, Texas area to join me as a co-panelist on “The Judicial Scrutiny of Arbitration Awards” panel.   Rick — who was recently appointed Fifth Circuit appellate counsel for Michael Motor Company, Inc. in Dealer Computer Svcs., Inc. v. Michael Motor Co., No. H-10-2132, slip op. (S.D. Tex. December 29, 2010), appeal pending No. 11-20053 (5^th Cir.) — is an experienced commercial litigator who handles commercial and insurance arbitrations here and abroad, a Chartered Institute of Arbitrators certified arbitrator in commercial and insurance cases, a frequently sought-after mediator, a member of the Texas House of Representatives Judiciary & Civil Jurisprudence Committee’s Arbitration Advisory Group, and a member of the International Institute for Conflict Prevention and Resolution (“CPR”)’s Arbitration Committee.  He was a contributing author to the American Bar Association publication, Elkouri & Elkouri, How Arbitration Works (6th Ed.), served as a trial judge in Louisiana, and is a former professor of Alternative Dispute Resolution law who has taught in Texas, England and Asia.

At the conference Rick and I discussed, among other things, some of the key differences between Scandinavian Reinsurance Co. v. Saint Paul Fire & Marine Ins. Co., 732 F. Supp.2d 293 (S.D.N.Y. 2010), appeal pending No. 10-910-cv (2d Cir.), and Dealer Computer, both of which concern arbitrator nondisclosure of alleged conflicts of interest (Dealer Computer also raises arbitrator qualification issues governed by Section 10(a)(4) of the Federal Arbitration Act.)

We were very happy with the presentation, which was well-received by attendees and other faculty members.  It was quite an honor to share the podium with Rick, and I hope we’ll collaborate on future projects.

The article is reprinted below with permission, and I would like to thank Elaine Song, a member of the New York Law Journal’s editorial staff, for her assistance and work in getting this published in New York’s leading legal trade publication.  

Reprinted with permission from the May 18, 2011 edition of the New York Law Journal© 2010 ALM media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com:

Outside Counsel

Arbitrator Evident Partiality Standard Under Scrutiny in ‘Scandinavian Re’

Philip J. Loree Jr. ContactAll Articles

New York Law Journal

May 18, 2011

•  Twitter
•  del.icio.us
•  Digg
•  Reddit
•  Google Bookmarks
•  Newsvine
•  LinkedIn
•  Mixx
•  Stumbleupon
• Print
• Share
• Email
• Reprints & Permissions
• Post a Comment

Philip J. Loree Jr.

Section 10(a)(2) of the Federal Arbitration Act (FAA) authorizes federal district courts to vacate arbitration awards “where there was evident partiality…in the arbitrators….”¹ Just as 28 U.S.C. §455 imposes impartiality requirements on federal judges, so too does Section 10(a)(2) on arbitrators.

To implement Section 10(a)(2)’s arbitral impartiality standards, courts have imposed on neutral arbitrators a duty to disclose circumstances that establish evident partiality. The scope of the duty to disclose relationships and interests that disqualify a neutral on evident partiality grounds, and what types of interests and relationships can establish evident partiality, are topics muddled by unclear, semantically malleable standards, which sometimes baffle judges, arbitrators, and in-house and outside counsel.

The pending appeal in Scandinavian Reinsurance Co. v. Saint Paul Fire & Marine Ins. Co.² presents the U.S. Court of Appeals for the Second Circuit with an opportunity to provide additional, meaningful guidance on arbitral impartiality standards, including arbitrator disclosure obligations. There the district court vacated a final arbitration award on evident partiality grounds even though none of the arbitrators had personal or financial relationships with the parties or interests in the outcome. The district court said the award had to be vacated because two of the arbitrators did not disclose to the parties facts about their involvement in an allegedly related proceeding—facts that would have no bearing on whether a similarly situated federal judge was impartial under much stricter judicial impartiality standards.

The question the court will decide is whether FAA Section 10(a)(2) authorized the district court to vacate the award under these circumstances. The answer should be “no,” and here’s why.

The District Court Decision

Scandinavian Re arose from a petition to vacate a final award issued by three experienced, well-known and respected industry arbitrators appointed to resolve a reinsurance dispute. The district court vacated the award because two arbitrators (one neutral, one party-appointed) did not disclose their temporally overlapping service on another arbitration panel hearing a case the district court characterized as concerning: (a) a common witness; (b) “similar” issues; (c) “similar” contract terms; (d) “the same type of reinsurance business”; and (e) a party that was the successor-in-interest to reinsurance business the prevailing party in the Scandinavian Re arbitration had assumed. (The parties dispute the accuracy of these findings, but, as we shall see, that doesn’t matter.)

The district court held that the arbitrators’ undisclosed, overlapping service in the other arbitration created “a material conflict of interest” establishing evident partiality:

[T]he Scandinavian Re Arbitration and the [other arbitration] were presided over by two common arbitrators, overlapped in time, shared similar issues, involved related parties, included…a common witness that supported interpreting [the agreement in the other arbitration] as written but interpreting the Scandinavian Re Agreement in light of Scandinavian Re’s intent at the time it entered into the agreement. Additionally, [another witness] was employed by [a party in the other arbitration which had purchased reinsurance business originally assumed by the prevailing party in the Scandinavian Re arbitration] at the time she appeared as a witness in the Scandinavian Re Arbitration. By participating in both [arbitrations, the arbitrators] placed themselves in a position where they could receive ex parte information about the kind of reinsurance business at issue in the Scandinavian Re Arbitration, be influenced by recent credibility determinations they made as a result of [the common witness'] testimony in [the other arbitration], and influence each other’s thinking on issues relevant to the Scandinavian Re Arbitration. By failing to disclose their participation in the [other arbitration], [the two arbitrators] deprived Scandinavian Re of an opportunity to object to their service on both arbitration panels and/or adjust their arbitration strategy….³

Analysis

The case turns on whether the Scandinavian Re arbitrators met arbitral impartiality standards, which are more demanding than judicial impartiality standards.⁴ While federal judges are disqualified for partiality “in any proceeding in which [their] impartiality might reasonably be questioned”—a/k/a the “appearance of bias” standard—in the Second Circuit “an arbitrator is disqualified [for evident partiality] only when a reasonable person, considering all of the circumstances, ‘would have to conclude that [the] arbitrator was partial to one side.’”⁵

Conventional wisdom suggests the Second Circuit should simply determine whether “a reasonable person…would have to conclude” the arbitrators were partial. But the Second Circuit can (and should) decide Scandinavian Re under explicitly defined standards set forth by statute and interpreted by U.S. Supreme Court and other federal courts: the judicial impartiality standards.

Chief Judge Frank H. Easterbrook of the U.S. Court of Appeals for the Seventh Circuit has demonstrated that initially considering whether arbitrators met judicial impartiality standards can greatly simplify the resolution of many evident partiality (and certain contractual, arbitrator-qualification) questions, because doing so not only avoids the philosophical debate and policy-oriented analysis that the “reasonable person would have to conclude” test invites, but in many cases, including Scandinavian Re, can provide added assurance about the validity of the outcome. For if arbitrators satisfy judicial impartiality standards, they necessarily satisfy arbitral ones, which are less demanding.⁶

What Are the Judicial Standards? The statute, 28 U.S.C. Section 455, sets forth the judicial impartiality standards that a federal judge must meet in each case over which he or she presides. Section 455(a) describes a “catchall,” “appearance of bias” impartiality standard: “(a) Any justice, judge, or magistrate judge of the United States shall disqualify himself in any proceeding in which his impartiality might reasonably be questioned.”⁷ Section 455(b) sets out specific circumstances under which a judge is disqualified from hearing a case because of actual bias or prejudice or certain personal, financial or professional relationships or interests that are presumed to conflict with the parties’ interest in having an impartial decision maker.⁸

Judges who do not meet these demanding judicial impartiality standards in any given case are obligated to recuse themselves, that is, to step aside and let another judge hear the matter. If they do not do so, and an appellate court rules they should have, then their orders and judgments may be vacated.

Were the ‘Scandinavian Re’ Arbitrators Disqualified Under §455(b)? The best way to assess impartiality under §455 is to consider first whether the arbitrators—were they federal judges—would have been disqualified on §455(b) grounds. The only §455(b) ground that might provide even a barely plausible basis for challenging impartiality in a case like Scandinavian Re is §455(b)(1), which requires judges to disqualify themselves “[w]here [they have]…a personal bias or prejudice concerning a party, or personal knowledge of disputed evidentiary facts concerning the proceeding.”⁹ But the Scandinavian Re arbitrators did not violate subsection 455(b)(1).

In Liteky v. United States,¹⁰ the Supreme Court explained that predispositions judges reach based on information obtained in an adjudicative capacity do not evidence Section 455(b)(1) “bias” or “prejudice,” except in extraordinary circumstances. The Court said the terms “bias” and “prejudice” “connote a favorable or unfavorable disposition or opinion that is somehow wrongful or inappropriate, either because it is undeserved, or because it rests upon knowledge that the subject ought not to possess…or because it is excessive in degree….”¹¹ Under the so-called “extrajudicial source doctrine,” alleged “bias” or “prejudice” generally cannot be based on knowledge obtained from participation in judicial proceedings, or on predispositions reasonably formed as a result, because there is nothing wrongful or inappropriate about judges having such knowledge or predispositions.¹²

Knowledge obtained from other proceedings; judicial opinions reached during those proceedings concerning applicable law and its application to facts; and judicial views formed during those proceedings concerning a party’s or witness’ credibility or character may cause a judge to be favorably or unfavorably disposed to a particular position, party or witness. But absent “deep-seated favoritism or antagonism that would make fair judgment impossible,” those predispositions are not “wrongful” or “inappropriate” and thus do not establish bias or prejudice.¹³

Assuming for argument’s sake that the district court’s factual findings were accurate, at most the Scandinavian Re arbitrators served in two proceedings featuring a common witness, some similar issues and contract terms, the same type of reinsurance business, and a related party. Even if there were no “extrajudicial source doctrine,” those facts would hardly suggest §455(b)(1) “bias” or “prejudice.”

But assuming (in the absence of evidentiary support) the arbitrators’ service in the other arbitration influenced their thinking in the Scandinavian Re arbitration, there is nothing wrongful or inappropriate about a judge—or by extension, an arbitrator—having or using in proceeding B knowledge or experience properly obtained in an adjudicative capacity from proceeding A.¹⁴ And nobody—including the district court judge—says that the arbitrators’ participation in the other arbitration resulted in “deep-seated favoritism or antagonism that would make fair judgment impossible.”¹⁵

The Scandinavian Re arbitrators also had no “personal knowledge of disputed evidentiary facts concerning the proceeding,” Section 455(b)(1)’s other basis for disqualification. Perhaps the arbitrators had already heard in one proceeding testimony on factual issues common to both, including testimony from a common witness. Perhaps they were already familiar with the relevant contract wording, which allegedly was similar.

But that doesn’t mean they obtained personal knowledge of the facts established or advocated in the other arbitration and thus could testify as fact witnesses in that arbitration, let alone in the Scandinavian Re arbitration. No one claims they were involved in or had personal knowledge of the disputed transactions; whatever knowledge they had was obtained solely in an adjudicative capacity.

Were the ‘Scandinavian Re’ Arbitrators Disqualified Under §455(a)? The only remaining question is whether the arbitrators were disqualified under §455(a)’s catchall, “appearance of bias” standard. Liteky provides an easy answer: A judge’s “impartiality” cannot “reasonably be questioned” where, as in Scandinavian Re, the alleged impartiality is based on knowledge obtained or opinions or views formed by the judge in the ordinary course of legitimately discharging his or her adjudicative responsibilities in another proceeding.¹⁶

Was There Any Legitimate Basis for the District Court’s Decision? The answer is “no.” Even if the strict judicial impartiality standards applied to the Scandinavian Re arbitrators, they satisfied them, and that necessarily means they satisfied the more lenient ones imposed by §10(a)(2).

The district court’s conclusion that the arbitrators had a “material conflict of interest” was therefore misplaced. The district court said the arbitrators “placed themselves in a position where they could receive ex parte information about the kind of reinsurance business at issue in the Scandinavian Re arbitration, be influenced by recent credibility determinations they made as a result of [the common witness'] testimony in [the other arbitration], and influence each other’s thinking on issues relevant to the Scandinavian Re Arbitration.”¹⁷ But a decision maker cannot have a “conflict of interest” unless he or she has a personal or financial interest in the outcome of the matter that conflicts with the parties’ interest in the decision maker’s impartiality.¹⁸ Liteky forecloses any argument that a decision maker’s discharge of legitimate adjudicative functions in matter A can create an “interest” in the outcome of related matter B, let alone a conflicting one.¹⁹

The risk that the arbitrators might “influence each other’s thinking on” allegedly similar, common issues likewise does not create a conflict of interest or otherwise establish evident partiality. That risk is present to some degree in appellate courts that use rotating, three-judge panels, and is particularly high in the U.S. Supreme Court, where the same nine justices generally hear each case. But nobody thinks that federal judges or Supreme Court justices must recuse themselves in matter B simply because they served together on the Court when it heard related matter A, and thus might influence each other’s thinking in matter B.

But Didn’t the Arbitrators Fail to Disclose Their Service on the Other Arbitration Panel? Some may think that the Second Circuit should affirm the district court because the arbitrators did not disclose their involvement in the other arbitration. They may think that the arbitrators’ failure to disclose their service amounted to evident partiality because it allegedly evidenced some deceptive motive on the arbitrators’ part that somehow spoiled the award. Alternatively, some may, like the district court judge, think that the arbitrators’ nondisclosure somehow “deprived Scandinavian Re of an opportunity to object to their service on both arbitration panels and/or adjust their arbitration strategy,”²⁰—even though an evident-partiality conclusion does not follow from that doubtful premise.

These arguments are misplaced for several reasons, but it is enough to say that accepting them would impose on arbitrators impartiality standards far more onerous than those federal judges must meet.

In the Second Circuit, courts may vacate awards for evident partiality where arbitrators fail to disclose a “material relationship with…a party” or a material interest—financial or personal—in the outcome of the arbitration.²¹ There is nothing controversial about that, for an arbitrator’s material relationship with a party or person or material financial interest in the outcome would establish partiality under both judicial and arbitral impartiality standards.

But in Scandinavian Re the undisclosed circumstances provided no basis for disqualification under Sections 455(a) or (b), which means that not even a federal judge would have been obligated to disclose them.²² The Scandinavian Re arbitrators were not required to disclose anything that a similarly situated federal judge would not have to disclose, and the Second Circuit should so rule.

Philip J. Loree Jr. is a partner at Loree & Loree in Manhasset.

Endnotes:

1. 9 U.S.C. §10(a)(2).

2. No. 09 Civ. 9531(SAS), 2010 WL 653481 (S.D.N.Y. Feb. 23, 2010).

3. Scandinavian Reinsurance Co. v. Saint Paul Fire & Marine Ins. Co., No. 09 Civ. 9531(SAS), 2010 WL 653481, at *8 (S.D.N.Y. Feb. 23, 2010), appeal pending No. 10-910-cv (2d Cir.).

4. See Applied Indus. Materials Corp. v. Ovalar, 492 F. 3d 132, 137 (2d Cir. 2007); Morelite Constr. Corp. v. New York City Dist. Council Carpenters Benefit Fund, 748 F.2d 79, 83-84 (2d Cir. 1984).

5. Ovalar, 492 F.3d at 137 (quoting Morelite, 748 F.2d at 84 (emphasis added)).

6. See Trustmark Ins. Co. v. John Hancock Life Ins. Co. (U.S.A.), No. 09-3682, 2011 WL 285156 (7th Cir. Jan. 31, 2011) (Easterbrook, C.J.); Sphere Drake Ins. Co. v. All American Life Ins. Co., 307 F.3d 617 (7th Cir. 2002) (Easterbrook, J.).

7. 28 U.S.C. §455(a).

8. 28 U.S.C. §455(b).

9. 28 U.S.C. §455(b)(1).

10. 510 U.S.540, 550 (1994) (Scalia, J.).

11. See 510 U.S. at 550 (emphasis in original).

12. 510 U.S. at 550.

13. 510 U.S. 550-51 & 555-56 (citations omitted).

14. See 510 U.S. at 550.

15. 510 U.S. at 555.

16. 510 U.S. at 552.

17. 2010 WL 653481 at *8.

18. See, generally, Trustmark, 2011 WL 285156, at *3.

19. See Liteky, 510 U.S. at 550-51 & 552-55; Trustmark, 2011 WL 285156, at *3.

20. See 2010 WL 653481, at *8.

21. Applied Indus. Materials, 492 F.3d at 137 (material financial relationship with a party); see also Pitta v. Hotel Assoc. of New York City, 806 F.2d 419, 423-24 (2d Cir. 1986) (material personal interest in the outcome); Morelite, 748 F.2d at 84-85 (father-son relationship with a party).

22. See Sphere Drake, 307 F.3d at 622.

The Chief Judge’s latest contribution to Federal Arbitration Act jurisprudence is Trustmark Ins. Co. v. John Hancock Life Ins. Co. (U.S.A.) , No. 09-3682, slip op. (7^th Cir. Jan. 31, 2011), and it is a welcome one.  In a characteristically terse and well-written ten-page opinion, the Chief Judge articulated at least eight Federal Arbitration Act rules pertinent to reinsurance and other forms of commercial and industry arbitration.  A few of these have been set forth before, while others are new:  

1. For the purposes of enjoining an  arbitration proceeding, a party does not suffer “irreparable harm”  simply because it must await the arbitration’s outcome  before obtaining judicial resolution of arbitrability or arbitrator-qualification  questions, see slip op. at 5-6; 
2. An arbitration agreement requiring arbitrators to be “disinterested” means the arbitrators must lack a “financial or other personal stake in [the arbitration’s] outcome,” see slip op. at 6;
3. An “arbitrator’s interest in reemployment created” by an arbitration clause that allows parties to choose their own arbitrators is not a “personal stake in the outcome” disqualifying an arbitrator, see slip op. at 6-7;
4. An arbitrator’s “knowledge about the dispute” is not a “disqualifying interest” in the arbitration’s outcome, see slip op. at 7-8;
5. Courts should not “abet [a party’s] .  .  .  strategy to eject the other party’s chosen arbitrator when that party is entitled to choose its own arbitrator, and in doing so follows all contractual requirements.  .  .  .,” see slip op. at 8;
6. Under the procedural-arbitrability doctrine, an arbitration panel in a subsequent arbitration has the authority to interpret and apply the terms of a confidentiality agreement reached during a prior arbitration proceeding, even if the confidentiality agreement does not contain an arbitration clause, see slip op. at 8-10;
7. Arbitrators have the authority to determine “the preclusive effect (if any) of an earlier [arbitration award,” see slip op. at 9-10; and
8. The question whether arbitrators exceeded their powers based on the outcome of an award is not whether they interpreted the contract correctly, but whether they interpreted it at all.  See slip op. at 10.  

Senior Circuit Judge Richard D. Cudahy and Circuit Judge Ilana Diamond Rovner joined in the Chief Judge’s opinion. 

Trustmark’s implications are many, particularly on the often interrelated topics of arbitrator qualifications and evident-partiality standards.  The author believes the Chief Judge’s opinion should influence the outcome of  pending appeals of two district court decisions vacating awards on the ground one or more arbitrators allegedly did not disclose (or fully disclose) service on a prior arbitration panel involving similar issues and contracts, or the same witness.   One of these is the appeal of the controversial decision in Scandinavian Reinsurance Co. v. Saint Paul Fire & Marine Ins. Co, No. 09 Civ. 9531(SAS), 2010 WL 653481 (S.D.N.Y. Feb. 23, 2010), which is pending in the United States Court of Appeals for the Second Circuit, and which was fully briefed and argued before Trustmark was decided.  The other is the recently-filed appeal of Dealer Computer Svcs., Inc. v. Michael Motor Co., No. H-10-2132, slip op. (S.D. Tex. December 29, 2010), which is pending in the United States Court of Appeals for the Fifth Circuit. 

Trustmark strongly suggests that the Second and Fifth Circuits should reverse the district court decisions in both Scandinavian Re and Dealer Computer.   In each of those cases the district court vacated an award because one or more arbitrators, through their service in other cases, had access to information or ruled on issues that were allegedly relevant to the proceedings that led to the challenged award. 

Trustmark undermines the district courts’ reasoning in Scandinavian Re and Dealer Computer because it demonstrates that even had the arbitrators in those cases been federal judges -- and therefore subject to more onerous neutrality requirements than those applicable to arbitrators --  the knowledge and experience they obtained from hearing cases involving the same or similar issues or a common witness would not have rendered them “interested” in the outcome, partial to one of the parties, or otherwise unfit to serve.   And if they could have served as federal judges in those matters, then the district courts unquestionably erred by holding that they lacked the requisite neutrality to serve as arbitrators. 

Scandinavian Re and Dealer Computer involved alleged non- or incomplete disclosure of arbitrator service on arguably similar or related matters, while Trustmark did not.    But the disclosure issue is a red herring.  Trustmark, construed in conjunction with Sphere Drake Insurance Ltd. v. All American Life Insurance Co., 307 F.3d 617, 622 (7th Cir. 2002) (Easterbrook, J.) – a case which the Chief Judge relied heavily on in Trustmark – demonstrates that the arbitrators in Scandinavian Re and Dealer Computer  were not required to disclose their service in other arbitrations allegedly involving similar issues or a common witness. 

To fully understand the implications of Trustmark on other cases, one must first understand the background of, and rationale for, the decision. Part II of this post will therefore discuss in some detail what transpired in Trustmark, and Part III will explain in more detail why, in light of Trustmark, the Second and Fifth Circuits should reverse the district court judgments in Scandinavian Re and Dealer Computer.     

[Editor’s Note:  The author is also publishing a materially identical version of this post in the Disputing blog.] 

In it I argue that the Stolt-Nielsen decision is both inexplicably broad and inexplicably narrow in scope, and may provide fodder for those who assert that Congress should enact the Fairness in Arbitration Act of 2009.  I also deconstruct the reasoning of the decision and explore some of its other practical and legal implications.   

Alternatives to the High Cost of Litigation is a subscription-only publication. Subscription information is available at this page, as well as at the publisher’s, John Wiley & Sons’s,  website here.

I would like once again to take this opportunity to thank CPR, and Russ Bleemer, Editor of Alternatives, for their kind assistance and support in featuring my article.   As I have said before, Russ is a keen,  intelligent and professional editor with whom it is a pleasure to work.

A.   Introduction

In Part I (here) we explained why the standard for challenging an award based on its outcome is important in reinsurance arbitration practice.  And, after briefly reviewing pre-Stolt-Nielsen law on outcome-based standards of review, we explained how Stolt-Nielsen has established a fairly searching, standard of review.  This Part II explores the legal and practical implications of that standard of review.    

B.   Legal Implications of the Stolt-Nielsen Decision’s Manifest Disregard of the Agreement Standard of Review

1.  Courts May Interpret Stolt-Nielsen’s Outcome-Based Standard of Review Liberally

Reinsurance-  and other commercial-arbitration awards are now subject to the same standard of review as labor-law awards – and in Stolt-Nielsen, the Court applied that standard of review pretty liberally.  The Court has put to rest the notion that Federal Arbitration Act Section 10(a)(4) vacatur is limited to questions concerning whether the arbitrators decided a matter falling within the scope of the parties’ arbitration agreement or submission.   The outcome of the arbitration is now subject to at least some, limited scrutiny. 

The focus will now be on whether the arbitrators interpreted, applied and enforced the contract, and applied applicable law or norms.  Express or implied reliance on extra-contractual considerations, such as public policy, may spoil an award, unless those extra-contractual considerations are grounded in applicable law.  Not heeding clear and unambiguous contract language, effectively deleting or disregarding contractual provisions or otherwise rewriting the contract may also subject the award to vacatur. 

Interpreting a contract according to reinsurance custom and practice will remain permissible, because doing so is usually consistent with contract interpretation rules, and, in any event, reinsurance contracts are supposed to be interpreted in light of custom and practice.  An award that relies on custom and practice would presumably draw its essence from the reinsurance contract, provided that the interpretation has at least a barely colorable basis in the contract or applicable law. 

Honorable engagement clauses will continue to give arbitrators a degree of discretion to depart from the ordinary meaning of contract terms, and permit certain looser interpretations that are based on honorable engagement.  But, as we have pointed out in a prior post (here), in jurisdictions that have adopted outcome-based standards of review, interpreting an honorable engagement clause as a license to rewrite a contract would be tantamount to inviting a court to vacate the resulting award.  Now that Stolt-Nielsen has adopted a uniformly applicable, outcome-based  standard of review, that is now true in all jurisdictions. 

Labor-law precedent construing the “manifest disregard of the agreement” standard is now more relevant than before.  In jurisdictions that had not previously adopted the labor-law standard of review in the commercial context, such precedent was often distinguishable.   That is no longer necessarily the case, and labor-law precedent interpreting the standard will be at least persuasive authority for how the standard should be interpreted in the commercial context. 

The relevance of labor-law precedent cannot be discounted, for it confines the role of the arbitrator to the interpretation and application of the contract more strictly than does commercial-arbitration precedent.  In part that is because the Labor Management Relations Act says that “[f]inal adjustment by a method agreed upon by the parties is declared to be the desirable method for settlement of grievance disputes arising over the application or interpretation of an existing collective bargaining agreement.”  29 U.S.C. §173(d) (emphasis added); see, generally, Wright v. Universal Maritime Serv. Corp., 525 U.S. 70, 77-80 (1998).  While the Supreme Court had not previously suggested that the federal policy in favor of arbitration is limited to “disputes arising over the application or interpretation of” a commercial contract, the Supreme Court in Stolt-Nielsen nevertheless declared that: 

It is only when [an] arbitrator strays from interpretation and application of the agreement and effectively ‘dispense[s] his own brand of industrial justice’ that his decision may be unenforceable.  In that situation an arbitration decision may be vacated under § 10(a)(4) of the FAA on the ground that the arbitrator ‘exceeded [his] powers,’ for the task of an arbitrator is to interpret and enforce a contract, not to make public policy.

Stolt-Nielsen, Slip op. at 7 (emphasis added).   The language used by the Court strongly suggests that a commercial arbitrator’s powers are co-extensive with that of a labor arbitrator, no matter how broad the scope of the arbitration clause.    

But we believe that the standard will probably not be interpreted quite as strictly in the commercial context.  Commercial arbitration is not subject to the LMRA, and the policy considerations relevant to labor arbitration — including the need to maintain industrial peace, and to protect the rights of individuals arising out of a collective bargaining agreement that is negotiated and entered into by the union in a representative capacity only – do not apply in commercial arbitration. 

Interpreting Stolt-Nielsen too literally would lead to anomalous results.  For example in labor arbitration statutory claims are not presumed to be arbitrable because they concern the meaning of a federal statute, not the interpretation or application of the agreement.   See Wright, 525 U.S. at 78-79.  Courts therefore require clear and unmistakable of an intent to arbitrate statutory claims.  See 525 U.S. at 80-82.  But in commercial arbitration such claims are arbitrable provided the parties agree to a broad arbitration clause, because commercial contracts are usually negotiated and entered into in an individual or entity capacity, and the parties are thus able to directly protect their own interests in the bargaining process.  See, generally,  525 U.S. at 80-82.

So the upshot is that labor precedent will likely inform a court’s application of the standard in the commercial context, but that the courts will not blindly apply it when doing so would be inimical to the purposes of commercial arbitration as expressed by commercial-arbitration precedent, and would effectively import into commercial arbitration a special rule or standard that serves only policy considerations relevant to labor arbitration.  But based on the standard articulated in Stolt-Nielsen, and the way the Court applied the standard to the facts, the Court has effectively said that the decisions of commercial arbitrators have to be based on at least barely colorable interpretations of:  (a) the contract or (b) applicable law and norms.   

2.  The “Manifest Disregard of the Law” Standard May be Subsumed in Whole or in Part within the Court’s “Manifest Disregard of the Agreement” Standard

While the Court stopped short of deciding whether the “manifest disregard of the law” standard of review survived Hall Street Associates LLC. v. Mattel Inc., 552 U.S. 576 (2008), the Court’s dictum–and even its holding—strongly suggest that the standard is not only alive but thriving.  The Court criticized the arbitration panel for not “inquiring whether the FAA, maritime law, or New York law contains a ‘default rule’ under which an arbitration clause is construed as allowing class arbitration in the absence of express consent .  .  . ,” and instead applying its own public-policy-based rule derived from other arbitral decisions.

That alone may be read as an admonition to arbitrators to interpret and apply the law, not their own rules, but there is more.  While the Court recognized that it could have remanded the matter to the arbitrators under Federal Arbitration Act Section 10(b), it did not because it concluded that no outcome was permissible under the Federal Arbitration Act under the facts before it other than the one it set out to articulate later in the decision.  Stolt-Nielsen, slip op. at 12. 

The Court thus did not consider the arbitrators authorized to disregard — let alone manifestly disregard — what it considered to be the applicable rule under the Federal Arbitration Act.  Whether that means the Court has effectively endorsed vacatur for “disregard of the Federal Arbitration Act” only, or “manifest disregard” of any applicable law, is open to question. 

The opinion suggests that the court was effectively endorsing the broader, “manifest disregard of the law” standard.  The Court stated that the panel went astray when it disregarded whatever law there was on the applicable default rule when the parties’ contracts are silent on class arbitration, and instead based its decision on its own notions of public policy.  So however the Court might have characterized the standard of review, it appears to encompass at least some situations that might otherwise be characterized as “manifest disregard of the law.”  Indeed, the Court noted that vacatur would be required in Stolt-Nielsen had the Court decided to apply a “manifest disregard of the law” standard. 

3.  Stolt-Nielsen May be Construed as Making Certain Public-Policy-Related Matters Non-Arbitrable, Even Under a Broad Arbitration Clause

Stolt-Nielsen may be construed as rendering public policy-based issues nonarbitrable, even when the parties’ arbitration clause is arguably broad enough to encompass them.  Stolt-Nielsen said that the role of arbitrators was not to make public policy, but to interpret and apply the terms of the parties’ contract, and ruled that the arbitrators exceeded their powers by imposing class arbitration based on their own notions of public policy.  The Court pointed out that the arbitrators had effectively–and erroneously–assumed the role of a common-law court in ascertaining and applying what it perceived to be applicable public policy.

But it should follow that the arbitrators never had the authority in the first place to decide the question whether class arbitration should be imposed as a matter of public policy.  Suppose a party asks an arbitrator to determine whether a provision in a reinsurance contract violates state public policy, but there is no state law on the books articulating the applicable public policy or stating whether or not the public policy does or does not justify enforcing a contract provision identical (or at least similar) to the one the arbitrator has been asked to rule upon.  In that circumstance the arbitrator would have to:  (a) ascertain whether there was or was not a relevant policy; (b) determine what the policy was and whether the contract provision was inconsistent with it; and, if the policy was inconsistent with the contract provision, (c) determine whether the policy is sufficiently important that it should trump a countervailing state policy of enforcing contracts according to their terms. 

It seems to us that, after Stolt-Nielsen, the parties should not be required to submit the public-policy issue to arbitration under the circumstances in the hypothetical above, even if their arbitration agreement was broad enough to encompass the issue.  For the arbitrators would simply be making a public policy determination that the Supreme Court suggested must be made by a common-law court, at least in the absence of any clear statutory or case law guidance on which the arbitrator could base his or her decision.    

C.   Practical Implications of the Manifest Disregard of the Agreement Standard

The most obvious practical implication that the decision will likely have will be to increase the frequency of motions to vacate.    Stolt-Nielsen has certainly affirmed that Section 10(a)(4) can and should be construed broadly to encompass a challenge to an award’s outcome.  And it has resoundingly approved applying the labor-law based “manifest disregard of the contract” standard to commercial arbitration awards, and implied that the standard encompasses, for all practical purposes, the “manifest disregard of the law” standard.  With courts around the country now uniformly having greater discretion to review arbitration awards, lawyers and their parties will no doubt seek to reap the perceived benefits of that discretion and to test its scope.    

While we do not believe that the Supreme Court has opened the proverbial floodgates to outcome-based challenges of arbitration awards, we do think that more will be granted.  How many more remains to be seen, but it is safe to assume that final arbitration awards have probably become a tad less final. 

Reinsurance arbitrators will have to take careful note of Stolt-Nielsen’s standard of review.  To ensure finality, their awards will need to be grounded in the contract and governing law and norms.  While most good arbitrators generally render awards that are so grounded, Stolt-Nielsen appears to have upped the stakes a bit, slightly increasing the risk of vacatur.  Arbitrators need to be familiar with the Stolt-Nielsen standard of review to help mitigate the increased risk.  

Stolt-Nielsen’s heightened standard of review may be a welcome development to some parties.  There are those in the industry who have complained that reinsurance arbitrations have become too unpredictable, and there are some who complain that they have been on the losing end of what they consider to be arbitrary awards.  Some of these parties no longer agree to include arbitration clauses in their contracts. 

The heightened degree of judicial discretion that Stolt-Nielsen permits may allay some or all of these concerns.  And depending on how courts interpret Stolt-Nielsen, parties that no longer utilize arbitration clauses might eventually reconsider that strategy.    

But there are other parties whose principal concern about arbitration is its cost.  Stolt-Nielsen is likely to increase the frequency of motions to vacate, and more will probably be granted.  Obviously that will result in increased arbitration-related costs, and that may lead some of these parties not to include arbitration clauses in some or all of their new contracts.  Or those parties may seek alternative, and presumably less costly, ways of resolving disputes, such as mediation or negotiation. 

As we suggested in Part I, the choice of the standard of review involves a delicate balancing act between competing considerations.  It is unclear to us at this juncture whether the balance struck by Stolt-Nielsen will encourage or discourage arbitration of reinsurance disputes.  Arbitration may be a foregone conclusion as respects disputes on old business, but its continued use on new business will depend in part on how the courts interpret this new, uniformly applicable standard of review, and on whether the Supreme Court ultimately decides to change it.

Editor’s Note:  Here’s a list of links for Parts I through V of our Stolt-Nielsen reinsurance-arbitration series: 

Part I, Part II, Part III, Part IV, Part V.A, Part V. B, and Part V. C

A.     Introduction 

Shortly before the United States Supreme Court decided Stolt-Nielsen, S.A. v. AnimalFeeds Int’l Corp., ___ U.S. ___, slip op. (April 27, 2010), we wrote about the implications the case might have on reinsurance arbitration practice.  (See our post here.)  But since then, you have not heard much from us, other than our brief report (here) about the Supreme Court vacating and remanding to the United States Court of Appeals for the Second Circuit the American Express Merchants’ Litigation judgment for further consideration in light of Stolt-Nielsen.   One — but by no means the only — reason is that after Stolt-Nielsen was decided, we wrote a comprehensive article on it, which will be published in a subscription-only publication in June. 

But that article – while comprehensive in scope – is directed at folks interested in the Federal Arbitration Act in general, not necessarily those interested in reinsurance arbitration in particular.  And that’s what we want to cover in this multi-part series:  Stolt-Nielsen’s implications on reinsurance arbitration practice. 

Stolt-Nielsen affects reinsurance arbitration in two very important ways.   First, it has set a fairly liberal standard of review that now applies to commercial arbitration awards in cases where a party asserts that the arbitrators exceeded their powers under Federal Arbitration Act Section 10(a)(4) because of the award’s outcome.  That, as we shall see, has all sorts of implications for persons involved in reinsurance arbitrations.

Second, it has changed the rules applicable to consolidated-reinsurance-arbitration practice – or at least it requires a wholesale reevaluation of those rules.  That, too, has a number of important implications for reinsurance-arbitration practice.   

This Part I of the series explains why the standard for challenging an award based on its outcome is important in reinsurance arbitration practice.  And, after briefly reviewing pre-Stolt-Nielsen law on outcome-based standards of review, it explains how Stolt-Nielsen has established for the lower courts a fairly searching standard of review.  Part II (here) will delve into what the implications of that standard of review will likely be. 

Part III (here) will provide the background necessary to understand how Stolt-Nielsen affects the law applicable to consolidated reinsurance arbitration.  Part IV (here) will delve into the details of how Stolt-Nielsen changes – or at least requires reconsideration of – the legal status quo in this area.  And Part V will discuss the implications of all of this.   

We do not set out to discuss the background of Stolt-Nielsen in any detail or to provide a play-by-play of how the Court decided the case.  If you are a regular reader you probably already know the background in detail, and our upcoming article does a pretty good job of mapping out the Court’s reasoning.  Instead, we focus our attention on the aspects of the decision that are relevant to the two key subjects of discussion. 

But before we delve into what Stolt-Nielsen has to say about the standard of review, we pause briefly to address why the standard of review applicable to an outcome-based challenge is so important in reinsurance and other forms of commercial arbitration. 

B.     Why is the Outcome-Based Standard of Review under Section 10(a)(4) Important to Reinsurance Arbitration Practice? 

Those involved in, or who have responsibility for, reinsurance arbitrations have good reason to be concerned about the extent to which a Court can vacate an award based on its outcome.  For the standard of review is not merely legal “mumbo jumbo,” but delineates the degree of discretion that a judge has to vacate an arbitration award.  That degree of discretion effectively acts as a check on arbitral power and determines how final a final arbitration award really is. 

Reinsurance arbitrators should be (and usually are) interested in the standard of review because it bears on how much discretion they have to decide a case in a particular manner.  Since arbitrators have institutional, reputational and economic interests in ensuring that their awards will be confirmed, they need to know how much discretion a judge has to second-guess their decisions. 

Parties likewise have good reason to be concerned about the standard of review.  The end product of arbitration will (or, at least, should) determine their rights and obligations, making one or both parties winners or losers.  Winners want that determination to be final; losers do not – and the scope of the standard of review determines (however loosely) the odds that the loser might get another bite at the proverbial apple. 

Parties also have institutional interests in the standard of review because it factors into the risk-benefit calculus that informs their decision whether to arbitrate in the first place.  The less discretion a judge has to vacate an award, the greater the risk that a party who agrees to arbitrate might be saddled with an arbitration award that bears little or no resemblance to what one would expect given the clear and unambiguous language of the contract and applicable law, custom and practice.  The more discretion a judge has to overturn an award, the more likely it is that arbitration will be followed by litigation, thereby increasing costs. 

The risk of high expense is inversely proportional to the risk of a wacky but unreviewable outcome.  If reinsurers and cedents are going to make informed choices about arbitration, they need to know where along the continuum of standard-of-review choices the law has attempted to strike the balance between these risks.

Attorney interests are aligned with those of their clients.  But to advance their client’s interests attorneys need to know the contours of the standard of review so that they can tailor strategy to maximize the chances that the client will reap whatever benefits the standard of review may have to offer.  For example, if the standard of review provides the court with some discretion to vacate an award that conflicts with the clear and unambiguous terms of the reinsurance contract, and those terms support the client’s position, then the attorney must not only forcefully argue those terms are controlling, but also make clear (diplomatically, of course) that an award inconsistent with those terms will likely be vacated. 

C.     The Legal Landscape:  The Section 10(a)(4) Standard of Review Prior to Stolt-Nielsen

To better understand how Stolt-Nielsen changed the standard of review applicable to outcome challenges, it is helpful to review briefly the somewhat confused, pre-Stolt-Nielsen law on outcome-based standards of review. 

Section 10(a)(4) of the Federal Arbitration Act authorizes courts to vacate an arbitration award “where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.”  Prior to Hall Street Assoc. v. Mattel, Inc., 552 U.S. ___ (2008), courts interpreted Section 10(a)(4) in at least two different ways.  Some courts interpreted Section 10(a)(4) as limited to challenges based on whether the matter decided fell within the scope of the parties’ arbitration agreement or submission.  That begged the question whether, and, if so, to what extent, the outcome of a commercial arbitration award on an issue within the parties’ submission was subject to any review at all. 

The Supreme Court had provided only indirect guidance on the subject.   The Steel Workers’ Trilogy cases, and their progeny, had ruled that, in labor arbitration cases governed by Section 301 of the Labor Management Relations Act (“LMRA”), the outcome of an award was subject to review to determine whether it drew “its essence from” the parties’ agreement, and was not based on the arbitrators’ “own notions of industrial justice.”  United Paperworkers Int’l Union v. Misco,  484 U.S. 29, 38 (1987);  United Steelworkers v. Enterprise Wheel & Car Corp., 363 U.S. 593, 597 (1960).   And, as respects commercial arbitration awards, the Court suggested in dicta in Wilko v. Swan, 346 U.S. 427 (1953), overruled on other grounds, Rodriguez De Quijas v. Shearson/American Express, Inc., 490 U.S. 477 (1989),  that an award could be vacated if it was in “manifest disregard of the law.”  This dicta was referred to with approval in First Options of Chicago v. Kaplan, 514 U.S. 938, 942 (1995).

Based on this somewhat obscure guidance, a number of courts that had interpreted Section 10(a)(4) of the Federal Arbitration Act as limited to challenges to arbitral authority developed independent grounds to review the outcomes of awards, whether for “manifest disregard of the law,” or failure of the award to draw its essence from the parties’ agreement, a standard that we shall refer to as “manifest disregard of the agreement.”  Some courts adopted both standards, some only one. 

But some other courts held that one or both of these “manifest disregard” standards were impliedly incorporated within Section 10(a)(4) and that vacatur under Section 10(a)(4) was not limited to situations where arbitrators ruled on an issue that was outside the scope of their authority.  These courts held that arbitrators exceeded their powers by manifestly disregarding the law, the agreement or both.   

Whether or not a court adopted one or both standards of review, and whether or not they deemed those standards of review to be within or without Section 10(a)(4), courts often articulated the standards of review differently, and applied them with varying degrees of strictness or laxity.  But for the most part, all courts were reluctant to grant relief based on them save in fairly unusual circumstances. 

In 2008 the Court decided Hall Street, which held that the Section 10 of the Federal Arbitration Act stated the exclusive grounds available to challenge a commercial arbitration award.  In dicta the Court discussed whether “manifest disregard of the law” might be encompassed within Section 10(a)(4), but did not decide whether that was so. 

Courts that had ruled that “manifest disregard of the law,” “manifest disregard of the agreement,” or both, were independent grounds for vacatur were forced to reconsider whether those standards were, in fact, independent, or whether they were subsumed within Section 10(a)(4).  This led to some conflicting authority, with some courts holding that one or both of those standards were subsumed within Section 10(a)(4) and others concluding that one or both of these outcome-based standards of review did not survive Hall Street .     

D.     What did Stolt-Nielsen Have to Say About the Outcome-Based Standard of Review? 

On June 15, 2009 the Supreme Court granted certiorari in Stolt-Nielsen to consider “[w]hether imposing class arbitration on parties whose arbitration clauses are silent on that issue is consistent with the Federal Arbitration Act, 9 U.S.C. §§ 1 et seq.”  As readers will recall, the parties had submitted to an arbitration panel the question whether the arbitration clauses contained in a series of charter-party agreements permitted or precluded class arbitration.  The Second Circuit held that the arbitration panel had not manifestly disregarded the law by imposing class arbitration on the parties even though their arbitration agreements were concededly silent on that score. 

On April 27, 2010, in a 5-3 decision authored by Associate Justice Samuel A. Alito, Jr., and joined in by Chief Justice John G. Roberts Jr. and Associate Justices Antonin Scalia, Anthony M. Kennedy and Clarence Thomas, the Court held that:  (a) the arbitration panel exceeded its powers under FAA Section 10(a)(4) by imposing class arbitration on the parties, because the panel’s decision was based solely on the arbitrators’ own notions of public policy rather than on the FAA, federal maritime, or New York State law; and (b) it was inconsistent with the FAA to impose class arbitration on the parties because it was undisputed that the parties had never consented to class arbitration, and implying such an agreement in the circumstances would drastically alter the nature of the parties’ agreement to arbitrate on a bilateral basis.

Although the Court could probably have decided the matter as one of arbitrability – the Stolt-Nielsen parties appeared to have reserved their rights to de novo review of the question whether the arbitrators had the power to render a binding decision on whether class arbitration was permitted in the face of silence – the Court initially addressed the question from the standpoint whether the award should be vacated based on the outcome.  And that determination required the Court to state the applicable standard of review for an outcome-based challenge to a commercial arbitration award. 

 The Court imported into the commercial context the labor-arbitration “manifest disregard of the agreement,” standard and found that it was subsumed within Section 10(a)(4).  It said that it was not deciding whether the “manifest disregard of the law” standard survived Hall Street (i.e., whether it was also part and parcel of Section 10(a)(4)), but declared that if it did, then it was satisfied here. 

Borrowing from the Steelworkers’ Trilogy line of labor arbitration cases decided about 50 years ago, and more recent labor-arbitration cases, the Court declared, “’It is only when [an] arbitrator strays from interpretation and application of the agreement and effectively ‘dispense[s] his own brand of industrial justice’ that his decision may be unenforceable.” Slip op. at 7 (quoting Major League Baseball Players Assoc. v. Garvey, 532 U.S. 504, 509 (2001) (per curiam)(quoting Enterprise Wheel & Car Corp., 363 U.S. at 597 (1960))).  

“In that situation,” said the Court, “an arbitration decision may be vacated under § 10(a)(4) of the FAA on the ground that the arbitrator ‘exceeded [his] powers,’ for the task of an arbitrator is to interpret and enforce a contract, not to make public policy.”  Applying that standard to the facts, the Court “conclude[d] that what the arbitration panel did was simply to impose its own view of sound policy regarding class arbitration.”  Slip op. at 7.

The Court explained that AnimalFeeds had made three arguments, one of which was that “the clause should be construed to permit class arbitration as a matter of public policy.”  Slip op. at 8 (quotation omitted).  Of the remaining two arguments, the panel had rejected one and said nothing about the other.  This led the Court to conclude that the arbitrators had accepted AnimalFeeds’ invitation to base its decision on public policy grounds.

The Court found further evidence that the panel based its decision on public policy in that the panel looked to previous arbitral decisions by other panels that had addressed the question and:  (a) “[p]erceiv[ed] .  .  . consensus among arbitrators that class arbitration is beneficial in ‘a wide variety of settings;’” and (b) considered “only whether there was any good reason not to follow that consensus .   .  .  .”  Slip op. at 9 (quotations omitted). 

The Court also found it relevant that the panel was not persuaded by Stolt-Nielsen’s unrebutted expert testimony — including testimony that there had never been a class arbitration under the form of charter party agreement used — or by pre-Green Tree Financial Corp. v. Bazzle, 539 U.S. 444 (2003) decisions holding that courts could not compel class or consolidated arbitration where the parties’ agreements were silent on that score.    Slip op. at 9; see, e.g., Glencore Ltd. v. Schnitzer Steel Products, 189 F.2d 264 (2d Cir. 1999); United Kingdom v. Boeing Co., 998 F.2d 68 (2d Cir. 1993); and Champ v. Siegal Trading Co., 55 F.3d 269 (7th Cir. 1995).

The Court said that because the parties had stipulated that they had reached no agreement on class arbitration, the arbitrators should have inquired whether the  FAA, maritime law, or New York Law contained a “default rule” that applied.  But instead, “the panel proceeded as if it had the authority of a common-law court to develop what it viewed as the best rule to be applied in such a situation.”

The Court was not persuaded by the “references to intent” in the panel decision, including a reference to the parties’ broad arbitration clause.  The Court pointed out that the parties stipulated, and the arbitration panel acknowledged, that the charter party agreement was silent on permitting or precluding class arbitration, and “that the charter party was ‘not ambiguous so as to call for parol evidence.’”  Slip op. at 11 (quoting panel decision).  The stipulation “left no room for an inquiry regarding the parties’ intent, and any inquiry into that settled question would have been outside the panel’s assigned task.”   Slip op. at 11.

The implications of the Court’s ruling on the standard of review are many, and shall be discussed in Part II (here).

Editor’s Note:  Here’s a list of links for Parts I through V of our Stolt-Nielsen reinsurance-arbitration series: 

Part I, Part II, Part III, Part IV, Part V.A, Part V. B, and Part V. C

In this part IV of our Nuts & Bolts vacatur feature, we focus on Section 10(a)(3) of the Federal Arbitration Act, which provides in pertinent part (with bracketed numbering and text added for convenience): 

[An arbitration award may be vacated:]

where the arbitrators were guilty [(1)] of misconduct [(a)] in refusing to postpone the hearing, upon sufficient cause shown, or [(b)] in refusing to hear evidence pertinent and material to the controversy; or [(2)] of any other misbehavior by which the rights of any party have been prejudiced[.]

Section 10(a)(3) might be referred to as a procedural due process provision, and courts sometimes suggests it defines the level of due process that must be present in an arbitration for a court to confirm the award without violating constitutional due process requirements.   We do not find that line of reasoning to be particularly helpful, and its validity is debatable.  But Section 10(a)(3) certainly prescribes a baseline level of procedural protection to parties who agree to arbitrate without expressly specifying procedural protections.  And it imposes a no-harm-no-foul rule:  procedural misconduct or misbehavior — including not following agreed procedural rules — does not undermine an award unless the misconduct or misbehavior prejudiced the challenging party.   

II.  Grounds for Vacatur under Section 10(a)(3)

Section 10(a)(3) says a court for may vacate an arbitration award for “misconduct” or “misbehavior.”  It specifies only two types of misconduct:  “refusing to postpone the hearing, upon sufficient cause shown” and “refusing to hear evidence pertinent and material to the controversy.”  But it contains a catch-all provision that authorizes vacatur when the arbitrators are “guilty.  .  .  of any other misbehavior by which the rights of any party have been prejudiced.”    We have discussed in a prior posts the Ninth Circuit’s recent decision rejecting certain Section 10(a)(3) challenges to a reinsurance arbitration award.  (Post here.)

The key to Section 10(a)(3) is whether the challenging party has been denied a “fundamentally fair hearing” or has otherwise been prejudiced.  And in evaluating whether that standard has been met, courts assume that when parties agree to arbitrate they trade-off some of the procedural “niceties” that apply in court.  So what might be considered the denial of a fundamentally fair hearing in court might be considered fair in arbitration.  For example, parties in arbitration are not entitled to the same discovery rights they might have in court, arbitrators are generally not bound to follow procedural and evidentiary rules strictly, and arbitrators generally have a great deal of leeway to formulate their own procedural rules, provided they do not conflict with the parties’ agreed rules (if any).       

A. Misconduct:  “Refusing to Postpone the Hearing Upon Sufficient Cause Shown”

An arbitrator’s refusal to grant a continuance can be a ground for vacatur, provided the party requesting it showed the arbitrator “sufficient cause” for it to be granted.  But this ground for vacatur is no panacea for those seeking to delay the day of reckoning, and arbitrators should not consider it as such.    

When courts evaluate claims premised on this ground, they usually accord the arbitrators a great deal of deference in determining what is “sufficient cause shown.”  Courts are not likely to deem “sufficient cause” was shown when the need for a continuance was the fault of the party that unsuccessfully sought it.  

But when the denial of a continuance prejudiced the challenging party, and the need for it was not of the challenger’s own making, then courts may grant relief.  For example, if a party who otherwise acted prudently could not produce an important witness at the hearing because the arbitrators denied a continuance, then this branch of Section 10(a)(3) may authorize a court to vacate the award.  The key questions are whether the arbitrator acted arbitrarily and whether the challenging party was prejudiced as a result.          

B.  Misconduct:  “Refusing to Hear Evidence Pertinent and Material to the Controversy” 

When parties agree to arbitrate, the law presumes they intended that the arbitrators would allow them to present material and pertinent evidence supporting their position.  That does not mean that a party is entitled to present cumulative testimony or seek the broad discovery permitted by the Federal Rules of Civil Procedure. 

If arbitrators exclude evidence which, if admitted and credited, would have justified a different outcome, then a court may grant relief.  Again, the touchstone is prejudice:  would the outcome have been different had the arbitrator admitted and credited the evidence?  Even if the outcome would not necessarily have been different, was the challenging party afforded a fundamentally fair hearing even though the arbitrators would not hear the proferred evidence?  

Burlage v. Superior Court of Ventura Cty., 178 Cal. App. 4th 524 (2d Dist. Oct. 20, 2009), rev. denied, No.  S178328 (Cal. Sup. Ct. Jan. 21, 2010), is an excellent example of the type of case where relief for excluding material evidence was warranted and granted.  As explained in prior posts (here and here), a seller and buyer entered into a contract to purchase land.  Seller knew that the land — including a swimming pool and a fence — encroached on an enjoining property but did not tell buyer.  A dispute arose between the parties concerning the encroachment, and buyer claimed that seller had defrauded it.  The dispute was submitted to arbitration as required by the arbitration agreement in the contract of sale. 

After the escrow closed, but before the arbitration hearing, the title insurer paid the adjoining landowner $10,950 for a lot-line adjustment that gave buyer title to the encroaching land.  But despite this buyer sought damages for alleged diminution in value of the property, and for the cost of moving the pool and fence that were situated on previously encroaching land that buyer now owned because of the lot-line adjustment. 

Seller sought to introduce evidence of the lot-line adjustment, and buyer moved to exclude it.  Buyer said that damages must be ascertained from the date of the escrow closing, a contention the seller disputed.  The arbitrator granted the motion, ruling that damages were to be fixed as of the date of the escrow closing, and excluded evidence of the effect of the lot-line adjustment had on buyer’s damages claim. 

At the hearing buyer’s experts testified that, as of the date of the closing, it would have cost approximately $100,000 to fix the problem.  The arbitrator’s prior ruling precluded the seller from rebutting that expert testimony by showing either:  (a) that there were no damages; or (b) that damages were limited to the amount of money the title company paid to fix the encroachment problem.  After the hearing the arbitrator ruled that:  (a) seller knew that the pool and fence encroached on adjoining land; (b) seller did not disclose this fact to buyer; and (c) the encroachment materially affected the property’s value.  The arbitrator awarded buyer $552,750 in compensatory damages, $250,000 in punitive damages, and $732,570 in costs and attorney fees. 

The trial court vacated the award and the Court of Appeal, Second District, affirmed 2-1.  The court held that the evidence the seller sought to introduce was material, its exclusion was prejudicial and vacatur was therefore warranted under California’s version of Section 10(a)(3), Cal. Civ. Code § 1286.2(a)(5):  

What could be more material than evidence that the problem was “fixed” and there are no damages?  Yet, the Burlages presented expert testimony about the effect of what had become a nonexistent encroachment.  Their experts testified about the cost to move a pool and fence, neither of which had to be moved.  Spencer was not even permitted to refute the Burlages’ expert who opined that the encroachment reduced the value of the property $100,000.  Spencer could not show that the title company solved the encroachment issue through a payment of approximately one-tenth that amount.

Without this crucial evidence, the arbitration assumed the nature of a default hearing in which the Burlages were awarded $1.5 million in compensatory and punitive damages they may not have suffered. An arbitrator must consider this evidence to make an informed decision.

178 Cal. App. 4th. at 530. 

But Section 10(a)(3) is not supposed to be a license for courts to second guess evidentiary and merits rulings by arbitrators.  For example, sometimes the question whether evidence is “pertinent and material” depends on the resolution of a legal question pertaining to the merits.  Suppose the parties disputed whether the law of State X permitted consequential damages for breach of contract in light of the circumstances presented.  And suppose the arbitrator rules that, under the facts at hand, the law of State X does not permit consequential damages, and subsequently refuses to hear evidence of consequential damages.  Assuming the basis for the arbitrator’s ruling on the legal question was at least barely colorable, then the plaintiff should not have any basis for vacating the award under Section 10(a)(3). 

Some might say that the Burlage case was wrongly decided for this very reason:  The arbitrator ruled that damages were to be “fixed” as of the date of the escrow closing in the sense that mitigation-of-damages evidence could not be introduced, and the arbitrator’s exclusion of the subsequently occurring lot-line-adjustment evidence was simply a logical consequence of that ruling.  But evidence of what subsequently transpired was material to the controversy over the amount of damages.   The amount the title company actually paid the adjoining landowner for the lot-line adjustment after the closing is highly probative of the amount it would have cost as of  the closing.  If the title company was able to resolve the encroachment problem for approximately $11,000 shortly after the closing, then it is more probable than not that buyer could have done the same thing at the time of the closing, even if it did not have title insurance.  And $11,000 is a whole lot less than the more than $1.5 million in damages and fees that the arbitrator awarded.

C.  Other Misbehavior that Prejudiced one of the Parties’ Rights

Section 10(a)(3)’s catchall provision allows vacatur where the arbitrators engaged in “misbehavior” that “prejudiced” one of the parties.  Misbehavior does not necessarily connote intentional wrongdoing by the arbitrators.  It encompasses procedural misconduct as well as procedural error, other than the two types discussed in Section A., above.  It also includes ex parte contacts.  But, as with “misconduct,” the no harm no foul rule applies:  The challenger must show prejudice.

One example of a case that may warrant relief under the catchall provision can arise when arbitrators change the rules midstream without affording the parties sufficient notice to adjust their case-presentation strategy accordingly.  Suppose an arbitrator rules that a party does not have to present evidence in a particular form to support his or her position, or that the elements of a party’s claim or defense are X, Y and Z.  Suppose the party relies on these rulings, but that the arbitrator, after the close of the hearing, rules that the party had to present evidence in a different form, or that the elements of one of the claim or defense were A, B and C, rather than X, Y and Z.   If the arbitrator issues an adverse award based on such a ruling, then the aggrieved party should be able to vacate it under the catchall provision of Section 10(a)(3).  

D.  A Word to Arbitrators

Lawyers appearing in arbitration proceedings will sometimes attempt to bolster their procedural arguments by suggesting that a ruling other than in their client’s favor will lead to vacatur under Section 10(a)(3).  For the most part, such claims should be taken with a grain of salt, since, as explained above, Section 10(a)(3) reaches only serious procedural errors that prejudice a party. 

In response to such claims, however, certain arbitrators attempt to insulate themselves against putative Section 10(a)(3) claims by simply granting virtually every request for procedural relief made by the parties.  That knee-jerk approach simply multiplies time and money costs, depriving the parties of one of the key benefits of arbitration. 

The better approach is to make the tough calls, actively manage the proceedings and move things along.  To do this effectively, while minimizing the chances that they may commit the type of procedural error that might spoil an award, arbitrators should familiarize themselves with the law interpreting Section 10(a)(3).

In part V of our Nuts & Bolts vacatur series we shall discuss Section 10(a)(4), which authorizes vacatur “where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.”

Chief Judge Easterbrook’s “agency” model of arbitral authority is instructive.  Just as agents derive their authority by the consent of the principal (subject to the rules of apparent and implied authority), arbitrators derive their authority from the parties via the arbitration agreement and the submission.  Subject to any restrictions in the arbitration agreement, the arbitrators’ powers to resolve a dispute under a broad arbitration agreement are arguably co-extensive with those of the parties that appointed them. 

But the model is not perfect.  First, unlike agents, arbitrators are not subject to the control of their principals and owe them no fiduciary duties.  Second, analogizing arbitrators as agents of the parties in the way Chief Judge Easterbrook does effectively empowers arbitrators not only to decide cases, but to negotiate settlements that the parties could have entered into.  It therefore does not require arbitrators to even arguably interpret the contract or apply the law:  As long as the arbitrators do not require the parties to violate the law, and as long as the arbitrators are at least arguably faithful to the parties’ expressed choice-of-law, if any, they can reach whatever decision they wish, whether by application of facts to legal norms or by a compromise settlement that may or may not be rooted in the parties’ agreement.    That arguably does not comport with the parties’ presumed, legitimate expectations.  For the arbitrator’s job is to decide cases; settlement is a matter for the parties, and should be subject to the parties’ control. 

University of Chicago Law School Professor Tom Ginsburg has written an excellent white paper that argues that the deferential standard of review espoused by Watts and other courts does not necessarily make arbitration an attractive substitute for litigation.  See Tom Ginsburg, John M. Olin Law & Economics Working Paper No. 502 (2d Series), The Arbitrator as Agent: Why Deferential Review Is Not Always Pro-Arbitration  (Dec. 2009) (copy available here).  He argues that a more searching standard of review would make the market for arbitrators more transparent, and thus more effective.  He advocates using Chief Judge Easterbrook’s agency model as an analytical framework for allowing parties to choose whether they prefer a very deferential standard of review, like that prescribed in Watts; something akin to de novo review, like that available in litigation; or something in between the two.  Professor Ginsburg is in the process of publishing in the University of Chicago Law Review an article based on his white paper.

As respects the tie-in between the standard of review and the effectiveness of arbitration, Professor Ginsburg explains that arbitrators are frequently experts in the subject matter of dispute, but, unlike “generalist judges,” they are not necessarily experts on the law or on the application of law to facts, and therefore are “prone to make mistakes, or at least presumptively more prone to do so than are judges.”  Since arbitration is a surrogate for adjudication, the U.S. legal system has had to decide what level of scrutiny best advances the federal policy in favor of arbitration.  Most arbitration statutes and the Convention on the Recognition and Enforcement of Foreign Arbitral Awards have eschewed mere legal error as a ground for judicial review of arbitration awards.  Only a particularly egregious error will warrant vacatur, and even then, courts differ as to what – if anything – constitutes an egregious error amounting to manifest disregard of the law (or perhaps manifest disregard of the agreement).   Courts consider this deferential approach as the one best suited to implementing a policy in favor of arbitration. 

But, as Professor Ginsburg observes, there is “a spectrum of possible alternative regimes, ranging from de novo review to complete non-reviewability,” and choosing which one best promotes arbitration involves a “tradeoff:” 

If the standard of review is too rigorous, the benefits of arbitration in terms of speed, cost, and finality may be lost because parties will frequently appeal arbitral awards to the courts.  On the other hand, if review is too limited, arbitrators might deliver very poor quality decisions that undermine the attractiveness of arbitration as a whole.

 Professor Ginsburg argues that Watts, Hall Street Assoc., L.L.C. v. Mattel , Inc., 552 U.S. ___, slip op. (March 25, 2008), and other court decisions trade off  too much in favor of speed, cost and finality by adopting a standard of review that amounts to practically no review at all.  He assumes, for the sake of argument, that there are “good arbitrators” that “always interpret the law accurately,” and “bad” ones who “do so only with a probability p < 1.”  He assumes that, in selecting arbitrators, a sufficiently large number of purchasers will seek “good” arbitrators (or “bad” arbitrators whose probability of interpreting the law correctly is close to 1.)  Parties will attempt to mitigate the risk of choosing a “bad” arbitrator through screening, but market imperfections tend to make the screening process unreliable: 

Will screening serve to adequately reduce the agency problem of arbitrators?  If the market for arbitrators is sufficiently robust, it might.  But the market for arbitrators has certain imperfections.  For example, there are no public records of arbitrator performance.  Arbitrators need not produce publicly available opinions, and parties generally have no incentive to allow them to reveal the basis for the award.  Only when an arbitrator makes an egregious error leading to a vacatur petition (such as manifestly disregarding the law outside the Seventh Circuit) will there be a public record of performance.  Hence it is difficult for the parties to a contractual dispute to evaluate potential arbitrators in terms of their ability to interpret law.  Reputational considerations are, of course, a factor, but in the absence of reasoned decisions, even past users of a particular arbitrator cannot be sure their favorable outcome resulted from skilled arbitration or a combination of lazy arbitration and luck.  There will thus be certain informational asymmetries in the market for arbitrators, allowing bad arbitrators to remain in the market.

A heightened level of judicial monitoring might compensate for some of these imperfections, says Ginsburg.  But decisions like Hall Street and Watts allow for only perfunctory review.  And while those decisions were intended to make arbitration more attractive, and to promote judicial economy as a result, Professor Ginsburg says their practical effect may be quite the opposite: 

One perverse result of the Hall Street decision might be greater pressure on courts to resolve full contract disputes.  One rationale for not allowing parties to contract into higher levels of judicial scrutiny (though not fully articulated in the Hall Street decision which relied on a textual analysis of the FAA) would be to enhance judicial economy — the public should not have to subsidize private dispute resolution. But after Hall Street, parties who want a legally proper decision cannot submit to arbitration, or at least will be less likely to do so, because there can be only minimal ex post monitoring of arbitral awards.  Like Watts, Hall Street limits the scope of review. But unlike Watts, it does not follow an agency perspective.  By preventing courts from policing arbitrator interpretations of law, Hall Street may end up reducing the number of cases sent to arbitration and, perversely, shifting contract disputes to the courts, precisely because there is no alternative way for parties to ensure that arbitrators do follow the law.  The Hall Street logic may end up sacrificing judicial economy in an attempt to preserve it, and hurt arbitration in the name of helping it.  (footnotes omitted) 

But if the parties could “designate the standard of review,” that “would improve the functioning of the market for arbitrators by allowing good arbitrators to signal their status[:]”

The point is that the standard of review will affect the mix of agents in the labor pool.  A policy of no scrutiny will draw bad types.  A policy of minimal scrutiny, such as under the FAA, will keep some bad types out: it will prevent arbitrators, for example, from applying New York law when they are instructed to apply Wisconsin law.  But it will do nothing to hinder an arbitrator who applies Wisconsin law so poorly as to produce an obvious error.  Given the existence of agency problems, the hands-off approach of the FAA after Hall Street may end up undermining the arbitration regime by drawing bad arbitrators.

So, working within the framework of the Federal Arbitration Act, and decisions other than Hall Street interpreting it, how do we justify a more heightened standard of review of arbitration awards?  Professor Ginsburg says the agency model itself provides the answer: 

An agency perspective would allow the parties more freedom in stipulating legal grounds for review.  If parties want a decision that is accurate, they could require that arbitrators not make clear errors of law.  High quality arbitrator-agents could trade on their ability to interpret law by promising not to make clear errors.  Low quality arbitrator-agents would not want to make such enforceable promises and so might be driven from the market.  The Hall Street approach limits contractual freedom; the Watts approach might expand it, and in doing so, may in fact enhance arbitration. It might thus allay concerns about a possible ‘flight from arbitration.’  (footnotes omitted) 

.  .  .  . 

Arbitration is contractual dispute resolution, and this means that arbitrators are agents. The standard of review of arbitral awards sets the level of monitoring of the agents’ interpretation of law. Some agents will prefer not to be subject to monitoring of their performance, and these are the agents who are happy with Hall Street.  Other agents have no fear of monitoring.  While specifying a universal standard of review applicable for all cases may be an inherently unstable venture, it seems clear that allowing the parties to set the standard, and to choose higher levels of monitoring by contract, will reduce agency slack and allow parties to determine what type of arbitrator they are hiring. Deferential review, in short, is not always pro-arbitration. 

We have quoted extensively from Professor Ginsburg’s work, but do not let this post be a substitute for reading and studying his white paper and the upcoming University of Chicago Law Review article.  Professor Ginsburg is a second-generation law and economics theorist, and like the first generation – whose ranks include Associate Justice Antonin G. Scalia, Circuit Judge Richard A. Posner and Chief Judge Easterbrook – he writes clearly and well, and more importantly — like those of the first generation – his theories make good sense, which is all too uncommon these days.

Arbitration is not a perfect process for resolving disputes, but neither is court adjudication.  One advantage of court adjudication is a fairly rigorous standard of review:  appellate courts generally review the trial court’s factual findings for clear error and legal conclusions de novo.  By contrast, courts review arbitration awards under the very deferential standards of review prescribed by Sections 10 and 11 of the Federal Arbitration Act.  The trade-off is one of informality, speed and reduced expense for a heightened risk that the decision maker will commit unreviewable legal and factual errors — even some pretty egregious ones.   

But every so often an arbitration award can be so far off the mark that one of the parties is deprived of the benefit of the bargain it made when it agreed to arbitrate.  These are not cases where the arbitrators merely did a shoddy job, but ones where the arbitrators did not do the job the parties asked them to do.  These are the cases that Section 10(a)(4) of the Federal Arbitration Act was designed to address:  ones where “the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final award on the subject matter was not made.” 

Today we take a brief look at Raymond James Financial Serv., Inc. v. Bishop, ___ F.3d ___, No. 09-1038, slip op. (4^th Cir. Feb. 22, 2010), a recent example of one of those rare cases.  And we’ll see how how confusion about the scope of Section 10(a)(4) resulting – quite unintentionally – from the United States Supreme Court decision in Hall Street Assoc., L.L.C. v. Mattel , Inc, 552 U.S. ___, slip op. at __ (March 25, 2008) apparently motivated the United States Court of Appeals for the Fourth Circuit to decide the case solely on the ground that the arbitrators were not authorized to rule on the claim on which they admittedly based their award.  (See, generally, “Hall Street Meets Pearl Street: Stolt-Nielsen and the Federal Arbitration Act’s New Section 10(a)(4).”)

The Court reached the right result, but its decision is of limited utility in future cases.  For under many broad arbitration agreements and submissions the arbitrators have authority to rule on pretty much any claim that is related to the subject matter of the  parties’ dispute.  Abitrators may have the authority to resolve a claim, but may do so in a way that has not even a barely colorable justification under the law and facts.   

We would have liked to see the Court rule not only on the authority issue, but also on two other grounds relied upon by the district court:  manifest disregard of the law and the award’s failure to “draw its essence” from the parties’ agreements.  As we have said before, we believe that those grounds are statutorily permitted by Section 10(a)(4), and that they provide a useful safety valve for addressing those (thankfully) rare cases where the arbitrators resolve a dispute within the scope of their authority, but do so in a way that completely deprives one of the parties of the benefit of its arbitration agreement.   

II.  Background

Raymond James Financial arose out of three separate agreements between registered broker-dealer Raymond James Financial Services, Inc. (“Raymond James”) and registered representatives Bishop, Hamant and Scanlon, each of whom was a financial advisor.  Bishop left his former firm, entered into a written, “Independent Sales Associate” agreement with Raymond James and became the branch manager of Raymond James’ Richmond, Virginia office.  Apparently at Bishop’s urging, Hamant and Scanlon each entered into separate “Financial Advisor” agreements with Raymond James, and joined the Richmond Office managed by Bishop. 

Each of the agreements established an independent contractor relationship between the signatory and Raymond James, and contained the following provision permitting termination without cause on five-days’ notice:

Either party may terminate this Agreement by providing the other party no less than five (5) business days prior written notice of intent to terminate this Agreement.  Given the unique transactional nature of the securities business, there is no need for a liquidated damages provision should either party voluntarily terminate the Agreement before the end of its term as neither party would be significantly damaged by such termination.

 None of the agreements contained arbitration clauses, but by virtue of the parties’ status as registered members of the National Association of Securities Dealers (“NASD”) (now the Financial Industry Regulatory Authority, Inc. (“FINRA”)), NASD  Rule 10101 — now codified in FINRA’s “Code of Arbitration Procedure” – required them to arbitrate “any dispute, claim, or controversy . . . arising out of  .  .  .  employment or termination of employment .  .  .  .” 

In 2003 Raymond James received misconduct complaints from competing financial advisors concerning Bishop’s Richmond, Virginia office.   As a result, in April 2004 Raymond James issued five days’ notice of termination to Bishop, and advised him that it was closing the Richmond office.  Like notices were apparently also issued to Hamant and Scanlon. 

The termination notices left open the possibility that Bishop, Hamant and Scanlon could re-affiliate with Raymond James at a different Raymond James branch.  Raymond James issued a two-month extension to effect the branch closing, and in June 2004 Bishop, Hamant and Scalon voluntarily terminated their employment. 

Prior to the voluntary termination, arbitration proceedings arising out of certain of the complaints were instituted against Raymond James and the three financial advisors.  Bostic, an in-house lawyer in Raymond James’ legal department, assumed the defense of Raymond James and each of the three financial advisors, and continued to represent the financial advisors after the Richmond office was closed.  The proceedings against Scanlon were concluded in his favor, and the district court found that the proceedings against him were likewise concluded in Hamant’s favor.  Hamant did not contest that finding even though he contended in the subsequent arbitration against Raymond James that the third-party proceedings against him had resulted in a $10,000 award. 

Raymond James discovered that an unauthorized person had gained access to its computer system, and it believed that person to be Bishop based on an internal investigation.  As a result  Raymond James began contemplating legal proceedings against Bishop, and, in December 2004, while the third-party arbitration proceedings against Bishop were ongoing, Bostic withdrew his representation of Bishop because of the conflict of interest.  But a few days after Bostic withdrew, the parties to the arbitration against Bishop entered into a global settlement that resulted in Bishop having no liability. 

In July 2005 Bishop, Scanlon and Hamant demanded a consolidated arbitration against Raymond James.   They asserted claims for damages based on:  (1) wrongful discharge; (2) breach of contract; (3) tortious interference with contract; (4) common law and statutory conspiracy; (5) violation of the Virginia Retail Franchising Act; and (6) violation of “just and equitable principles of trade.”

In December 2006, after a several-day hearing, the arbitration panel ruled that Raymond James was liable on the following grounds: 

breach of fiduciary and legal duties; violation of just and equitable legal principles of trade; breach of promises and inducements; interference with, and unlawful termination of [the financial advisors’] .  .  .  prospective economic advantages; interference with the performance of contractual promises and inducements; tortious and deceitful termination of [the financial advisors’] .  .  . legitimate and high business expectations; violation of statutory Virginia public policy set forth in Virginia code § 13.1-558; and common law and statutory conspiracy.

The Panel awarded Bishop $156,050; Hamant $74,050; and Scanlon $72,050. 

The Panel’s award explained that Raymond James engaged in “unauthorized practice of law [sic] by employing staff counsel to advise and represent [the financial advisors] .  .  .  in their individual capacities” in the underlying, third-party arbitrations.  The Panel found that Raymond James did not warn the financial advisors that they would be subject to heightened scrutiny because of the complaints.  And the Panel found that Bostic’s withdrawal prejudiced “some or all [of the financial advisors’].  .  .  litigation interest and made their transfer to other Raymond James Services, Inc. branch offices impossible as a practical matter.” 

On Raymond James’ motion to vacate, the district court initially remanded the matter back to the arbitrators because it could not discern any basis for the award.   In April 2008 the Panel issued a letter explaining three bases for its award: 

(1) Raymond James provided legal representation to the [financial advisors] .  .  . “in a matter involving a business relationship between the employer and [the financial advisors] .  .  .  that was also adversarial with a clear conflict of interest;” (2) Raymond James’ “attorney favored the interest of [Raymond James] to the disadvantage of the [financial advisors].  .  .  who were also his clients;” (3) “if a corporation employs a lawyer to provide legal services that corporation is then engaged in the practice of law .  .  .  .  As such, it is held to the same standard as a law firm and owes to its client the highest degree of fiduciary duty.  If it chooses to engage in the business with such clients, it is obligated to place the interest of those clients ahead of its own. [Raymond James] failed in that obligation and the [financial advisors] .  .  .  suffered losses pertaining to the issues for which [Raymond James] provided its lawyer.”

In June 2008, the arbitrators supplemented their clarification letter by stating that “[t]he unauthorized practice of law was one among other factors considered by the panel and that considering the case as a whole [it] believes the liability decision to be just and appropriate.”

The Court’s discussion of the proceedings below was somewhat detailed, but for the purposes of this post, we need not dwell on it.  Suffice it to say the district court vacated the award on three independent grounds:  (1) the arbitrators exceeded the powers conferred upon them by Rule 1010 and the submission; (2) the arbitrators manifestly disregarded the law, because Florida law required a party to show damages to establish a breach of fiduciary duty claim and there were no damages; (3) the award did not “draw its essence” from the parties’ contracts because the “gravamen” of the claim was for wrongful termination, the parties’ contracts permitted termination without cause on five days’ notice, and in any event, the financial advisors ultimately voluntarily terminated their relationship with Raymond James.   

III.  The Fourth  Circuit’s Decision

The Fourth Circuit affirmed, but only on the ground that the arbitrators exceeded the authority granted to them by Rule 1010 and the parties’ submissions.  The Court also found that the remand to the arbitrators was proper insofar as the district court did not know what to make of the award, a point we need not address here.   

The Fourth Circuit’s rationale was based on Rule 1010, which required arbitration of “[a]ny controversy . . . arising out of the employment or termination of employment .  .  .  .” of registered representatives. Prior case law in the Fourth Circuit had construed this language broadly to mean “that a dispute ‘arises out of employment or termination of employment,’ where the claims ‘involve significant aspects of the employment relationship, including but not limited to explicit contractual terms.’”   The “’proper question is whether resolution of the claim depends upon evaluation of a party’s performance either as a broker or as an employer of brokers during the time of the contractual relationship.’”  Slip op. at 17 (citations omitted). 

The Fourth Circuit agreed with the district court that the gravamen of the financial advisors’ claims was for wrongful termination, but that the arbitrators, by their own admission, decided the case, and awarded damages, based on Raymond’s James’ alleged breach of fiduciary duty, a claim the parties neither submitted to arbitration  nor were required to arbitrate pursuant to Rule 1010:

As we have noted, here the arbitrators based their award on Raymond James’ alleged breach of “fiduciary and legal duties” in connection with their joint representation with Raymond James by Bostic, the inhouse lawyer.  Under the Zandford “significant aspects” test, the appropriate question here “is whether resolution of the claim depends upon evaluation of a party’s performance either as a broker or as an employer of brokers during the time of the contractual relationship.”  The panel’s assertion that Raymond James acted improperly as a “lawyer” is inconsistent with the notion that Raymond James was acting as an “employer of brokers during the time of the contractual relationship.”  There is nothing whatsoever in the serial explanations provided by the arbitration panel to support the conclusion that the legal theory the panel found sustained required an evaluation of any party’s “performance.”  Even after the district court ordered a remand to the panel, the panel simply reiterated what seemed inescapable from the original award: that the panel had adjudicated a tort claim that fell outside of the expansive interpretation of “arising out of employment” we adopted in Zandford.

Slip op. at 18 (citations omitted). 

IV.  Analysis

While we believe the Court’s excess of authority analysis was basically sound, it required the Court to parse the language of Rule 1010 pretty thinly.  The focus should have been on the parties’ submission rather than the language of Rule 1010.  Notwithstanding the Court’s statement that Raymond James’ purported activities as a “law firm” were inconsistent with it being an employer, Bostic’s provision of counsel to the financial advisors was something that, at least arguably, “arose out of employment . . . .” within the meaning of Rule 1010.  It would have been cleaner — and more consistent with an “expansive interpretation” of Rule 1010 to have simply ruled that the parties did not submit to the arbitrators the issue of Raymond James’ joint representation of the financial advisors in the third-party proceedings. 

The Court quietly took a pass on whether the award was in manifest disregard of the law or did not “draw its essence from” the parties’ contracts and simply explained in a footnote the controversy surrounding the continued viability of those theories in light of Hall Street.  See Slip op. at 18 n.13.  To address these two other bases relied on by the district court, the Fourth Circuit would have had to decide:  (a) whether Hall Street permitted vacatur on those bases to the extent that they were within the ambit of Federal Arbitration Act Section 10(a)(4); (b) whether they were in fact within the ambit of Section 10(a)(4); and (c) whether the facts justified vacatur under one or both of them. 

We are mindful that the principal purpose of the federal judiciary is to decide cases and controversies, and the Fourth Circuit fulfilled that purpose here, while avoiding the mire created by the manifest disregard dictum in Hall Street.  But we would have preferred a bolder approach under which the Court would have ruled on the manifest disregard and “essence of the agreement” challenges, simply because that would have given litigants more guidance in future cases, particularly ones in which arbitrators reach a ruling lacking a colorable basis in the course of deciding a claim within the scope of their authority. 

Had the Court opted to analyze the case from the standpoint of manifest disregard of the law and “essence of the agreement,” we believe that it might have affirmed the district court’s decision on those grounds as well.  There was simply no colorable basis for this award, and we believe the only reasonable conclusion one can reach is that the arbitrators decided to punish Raymond James for what they misperceived to be wrongful conduct on the part of Bostic — allegedly wrongful conduct that was not the basis of the financial advisors’ claims. 

Even if the breach of fiduciary duty claim were arbitrable, there was no basis for the damage awards.  Bostic’s withdrawal from the Bishop third-party proceedings had no affect on the third-party proceedings against the other two financial advisors – those proceedings were concluded before Bostic withdrew from the Bishop proceedings.  But apart from that, the Bishop proceedings resulted in a global settlement under which Bishop had no liability. 

 Even if we ignore what the arbitrators said in response to the district court’s remand order, and treat the arbitrators’ award as one for wrongful discharge, there could be no wrongful discharge because Raymond James complied with the termination provision in the contract, which allowed discharge on five days’ notice without a showing of just cause.  The termination clause also expressly acknowledged that there would be no meaningful damages in the event of a termination (wrongful or otherwise) in view of the transactional nature of the securities industry (in which compensation is largely based on commission). 

In any event, Raymond James’ compliance with the termination clause was irrelevant because each of the financial advisors voluntarily terminated their relationship with Raymond James after the expiration of a two-month extension of time to close the Richmond office.  A voluntary termination is by definition not wrongful.

While judicial restraint is generally a good thing, an affirmance on the three bases the district court relied upon would have resulted in a more meaningful and useful decision.